Understanding carbon costs in the supply chain

09 Jun 2011Archived News Climate Change Matters

The impact of a cost of carbon on a business will be more than simply the direct cost increases (energy price increases or increased cost of refrigerants and other greenhouse gases).

 

A well prepared organisation will also need to understand and plan for all of the supply chain and other indirect costs, as well as the compensation mechanisms in place for many sectors. To position your business to best advantage, it is important to understand the impacts on sensitive customers and the ability to pass-through costs: as received from suppliers and in turn, pass onto customers.

 

The Federal Government will announce a carbon price in July for introduction in 2012. Although it is anticipated to have a modest overall impact on the national economy with Treasury modelling (1) implying a small decrease in GDP growth under different pricing scenarios to 2050, and modest cost impacts in most businesses, there will be variation by sector. All businesses should evaluate their impacts and where significant, establish a comprehensive, strategic response.

The importance of a carbon strategy

A carbon strategy should identify and minimise risk, investigate opportunities to introduce new products and services, establish carbon abatement targets, pursue energy efficiency programs, investigate new technologies and behavioural change campaigns. The drivers for such initiatives are not just focussed on cost concerns. As the Australian economy transitions to lower its carbon emissions, markets will be redefined and business brands will transform.

Financial markets favour organisations that disclose their risks, have a strategic plan in place and support a management culture of transparency. This in turn will direct longer term investment decisions and support the structural change necessary to achieve the transition to a low carbon economy.

Carbon exposure: risks and opportunities

The range of impacts across your supply chain is one of the key insights businesses need to develop. Considerations include:

1. how a carbon cost changes your suppliers and the availability and cost of your inputs,
2. impact on your costs and profits, and
3. impacts on your customers and their desire to buy your goods and services.

If your customers materially change their business in response to carbon, the impact on your business could be substantial.

Furthermore, by decarbonising your supply chain and lowering the carbon intensity of your products or services, your business can also reduce its exposure to volatile and rising energy prices, the impact of which is far greater than the effect of a price on carbon.

1. Reducing the carbon intensity of your business

Many large businesses have been exploring the opportunities to decarbonise the supply chain and reduce costs.

It may become more competitive to source some business inputs from an alternative supplier or location, or it may be more economical to switch to alternative products or processes. These less obvious supply chain impacts can be quite material to your business. If your suppliers or customers are heavily affected, there will be implications in turn for your business.

2. Managing the pass-through of costs

All contracts should be reviewed to assess the ability to pass on cost increases.

Many energy contracts have a direct pass-through clause, while for other business inputs the cost may flow through more subtly. To protect your company's profits, you should understand who is required to absorb the full cost, and whether, across your supply chain there are opportunities to switch to alternative business inputs with a lower carbon cost.

However, there are broader considerations beyond cost avoidance. Does the extent to which you can pass-through make your product less competitive than your opposition's? Does the pass-through make your customers' products uncompetitive?

Industries such as construction, building suppliers and retailers have greater opportunity to pass carbon costs through to their customers. Another interesting scenario exists for larger suppliers which have the opportunity to dictate supply costs because they are a monopoly or a duopoly.

Compensation

Energy-Intensive Trade-Exposed Industries (EITEI) industries such as cement, steel, LNG and aluminium are exposed. International prices and competition from imports prevent cost increases being passed on. The Government is expected to provide compensation for these industries thereby reducing the carbon price impact.

Ahead of the introduction of a price on carbon a comprehensive analysis should be undertaken to not only review your contracts and improve the ability to pass-through, but to understand the range of implications, particularly for your customers.

3. Focussing on the customer and identifying new low carbon opportunities

Innovative, forward thinking businesses will look for the opportunities presented by a transition to a low carbon economy.

Prioritising business investment

A business can lower its carbon exposure through carbon abatement activities. Using a greenhouse abatement options cost curve (click here to read more) energy efficiency, carbon abatement, implementation of new technologies and behavioural change programs can be ranked according to their cost-effectiveness and emissions reduction potential. This demonstrates to your customers that you are managing your own carbon exposure cost effectively.

Some abatement programs may include options not previously considered, such as the emissions associated with waste. A campaign to minimise waste not only reduces a business' carbon liability, but landfill charges which are increasing independently of a price on carbon. Overall, an organisation can become more lean and efficient.

The development of low carbon products and services, and the entry into possibly new markets, may redefine your business' brand, and attract new customers who in turn seek to minimise their carbon exposure. In the example of the building sector, low carbon retrofit and design solutions will become the standard, and present new opportunities to innovate as the industry looks for building solutions, not just products.

1* Australia's Low Pollution Future, The Economics of Climate Change Mitigation: Treasury: “From 2010 to 2050, real GDP per capita grows at an average annual rate of 1.2-1.3 per cent in the policy scenarios, compared to 1.4 per cent in the reference scenario”, Executive Summary, pg xi., 2008.

Written by Chris McPherson and Peter Holt
 

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